Friday, 16 March 2018

Why the collapse of Carillion is a governmental failure

Deborah Mabbett

The collapse of Carillion has brought the usual suspects into the spotlight. Senior executives prospered on over-generous pay packets. Shareholders did not ask awkward questions as long as dividends were bouyant. Auditors did not raise issues about accounting methods that, with hindsight, inflated reported profits. Telltale weaknesses in the company’s cash position were ignored.

Alongside these familiar features, there are some surprises. Contrary to the established notion that the private sector extracts excessive profits from public contracts, it turns out that margins are very low, in the construction sector in particular. With just a 2-3 per cent margin of revenue over costs, providers are very vulnerable to cost overruns. Contracts are structured so that providers bear risk: there is little scope to return to the purchaser and renegotiate terms. The general principle that profitability should be proportionate to risk was apparently not honoured.

In the world of public-private financial dealing, there seem to be many examples where profits are made but risk is not borne; evidently there are also some cases where the opposite occurs. This raises the uncomfortable possibility that the government has been underpaying on some projects.

Who is to blame?

One way to manage risk is to diversify, and this is the strategy that Carillion embraced. It took on an unlikely array of activities from providing school meals to running prison estates to building hospitals and participating in the development of HS2. While Carillion remained primarily a construction company, its strategy of growth through acquisitions mimicked that of giant outsourcing conglomerates such as Serco and Capita. These companies have moved into areas where they have no apparent operating competence: their portfolios of activities have nothing in common except that the public sector is the counterpart or purchaser. Insofar as they have any specialised skills in their internal corporate employment, they are the skills of tendering for public sector contracts. The obvious problem with this strategy is that it foregoes the development of expertise in a sector in favour of the skills of bid-writing and financial jiggery pokery.

We can choose to blame the executives of these conglomerates for their drive for growth. But we can also blame the government for its insistence on putting out large scale contracts which place high risks on providers, knowing, as it must, that this will produce a sort of adverse selection among the bidding companies. Not only are large conglomerates more able to cope with the risks than smaller specialists, but also companies with a penchant for financial engineering are favoured over those which shelter and nurture complementary and specialised skills in their workforces. The UK construction sector is notoriously poor in maintaining and developing its skill base, and Carillion’s diversification strategy tells us something about the reasons why.

Reforming procurement

The government has to accept and develop an approach to contracting where it shifts less risk. This has major implications for contract management on the government side. Without so much risk-shifting, public procurers would have to monitor and negotiate over contracts in an ongoing way. Smaller contracts would allow more firms to bid, but smaller contracts mean more contracts for the procurer to manage. The public sector no longer employs the people who could undertake this management. The government has favoured risk-shifting at the same time as it has stripped its own base of skills and drastically depleted the number of civil servants available for these tasks. It has become dependent on the large private providers of public services in a very fundamental way, for management as well as for delivery. This dependence is indicated by the government’s continued willingness to contract with Carillion long after its financial difficulties became apparent.

Renationalisation may be the best option in some areas. At present, renationalisation occurs covertly and accidentally, as private providers fail and the government takes ownership and management of assets back under its control. But the overextension of outsourcing and excessive reduction in public sector employment implies that it is not reactionary or backward-looking to consider actively promoting further renationalisation of public service provision.

Rethinking the structure of procurement means rethinking the balance between hierarchical internal control and arms-length contracting. It means employing more people in the relevant parts of government, and not all on consultancy contracts – a practice which is itself a privatisation of expertise. It means retaining more residual control rights over the use of assets and the allocation of profits. Renationalisation need not look like 1945 all over again: it can be a selective process in which the private sector continues to provide services, but under different contractual models.

Not everything about outsourcing has been a disaster. Incremental and selective renationalisation should keep good practices where they have developed, such as the explicit costing of public service obligations and the monitoring of performance by separate regulatory bodies. Furthermore, some of the most objectionable features of outsourced provision can be addressed through contract terms - providers should operate under a ‘social licence’, including requirements to pay living wages and adopt fair practices in their own supply chains.

How not to do industrial policy

Mariana Mazzucato made a splash in 2013 with her account of the ‘entrepreneurial state’. Her cases were drawn from the US and she concentrated on the role of the government in promoting research and development: in effect bearing risk in a particularly risky form of investment. But her argument contains a more general point: that governments can organise their procurement in ways which allow companies to invest in specific skills and technological innovations, and these companies can become good employers and internationally competitive entities. The conditions are that the government brings funds, capacity and ambitions to its programme for public services: ambitions to improve the quality of services, promote sustainability and expand opportunities.

In the Industrial Strategy White Paper published by the government in November 2017, procurement is explicitly acknowledged as an instrument of industrial policy. Treasury data indicate that the government spends some 14 per cent of GDP on procurement, a scale which means that its procurement practices shape the economic fortunes of key sectors, particularly construction and transport.

But the government shows no sign of learning Mazzucato’s lessons about the entrepreneurial state. Nearly a decade of austerity has left us with a government with no ambitions, little willingness to commit its own financial resources, and a civil service stripped of capacity. The small story of Carillion is of a corporate failure; the larger story is of government failure and the profound depletion of the public sector.

Deborah Mabbett is Professor of Public Policy at Birkbeck, University of London.

This blog is adapted from Deborah Mabbett’s editorial commentary in The Political Quarterly journal, available soon.

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